Play This ‘Demographic Dividend’ Long-Term

by Alyssa Oursler | January 15, 2013 2:30 pm

In 2012, one of the biggest trends was a hunt for yield, as investors sought steady income in the form of dividends. In fact, the then-looming fiscal cliff led to an eye-popping number of special dividends[1] in the final month of the year — a nice bonus for certain companies’ shareholders.

I’d like to introduce you to a different kind of dividend, though — one that’s not quite as quantifiable, but that can still put money in your pocket: the “demographic dividend.” The Population Reference Bureau[2] describes it as the “accelerated economic growth that may result from a decline in a country’s mortality and fertility.”

See, a common misconception is that population growth and a large youth population are indicators of strong growth potential — in reality, the opposite is true.

As the PRB explains:

“With fewer births each year, a country’s dependent population grows smaller in relation to the working-age population. With fewer people to support, a country has a window of opportunity for rapid economic growth if the right social and economic policies [are] developed and investments made.”

Timing is everything, though.The aforementioned dependency ratio (dependent vs. working population) moves in a U-shaped trend. While dependency levels fall in the wake of falling birth rates, the large working population that results eventually ages and then increases the dependent population yet again — just as is happening with Boomers here in the U.S.

The demographic dividend is the sweet spot before the trend levels and reverses.

Why should you care? Well, you could cash in on the resulting economic growth of a country attaining a demographic dividend by investing in its exchange-traded fund or relevant companies.

Let’s take a look at a few examples:

Too Late

South Korea is a prime case study for this trend. The country made a quick transition from high to low fertility[3] from 1960 to 1990 — as seen in the dependency ratios in the graph below — while at the same time experiencing annual GDP growth of 6.7%.

By 2000, though, the dependency trend reversed slightly before bottoming in 2010. It is expected to start increasing again as that working population ages.

China’s dependency ratio also declined until 2010 before starting to flatten out. As you know, the country experienced significant economic growth in that lead-up. In fact, the Xinhua China 25 IndexFund (NYSE:FXI[4]) grew along with it. From its inception in 2004 until 2010, it gained nearly 40% annually before more recently slowing down and moving sideways.

In both cases, the demographic trend is already reversing, so investors are late to the growth party. Most of the potential hiding in these countries’ demographics has already been realized.

Too Early

While the dependency ratios of India and South Africa are indeed on their way down still, they aren’t moving quite as rapidly as the previous two examples were, and aren’t expected to bottom out until around 2040 and 2045, respectively.

Investors who believe demographics could be a boon to growth could hop in the WisdomTree India Earnings Fund (NYSE:EPI[5]) or the iShares MSCI South Africa Index Fund (NYSE:EZA[6]), but it could take decades before any real payoffs come of it.

Of course, also remember that the dividend only helps “if the right social and economic policies [are] developed and investments made.” It’s just one contributing factor, and is far from a guarantee.

Just Right

Still, things do look pretty good for one country in particular: Mexico. Mexico’s dependency ratio has been falling since it bulged in the ’70s and is set to bottom out just before 2030. That makes now — around two decades before the reversal — a prime time for the country’s demographics. The ratio still has room to drop — and accelerate economic growth — plus you won’t have to wait 20 or 30 years to possibly see growth as a result.

Of course, again remember that such a demographic transition is just one piece of the puzzle. It’s an even more compelling one if you’re bullish on Mexico’s market to begin with, though.

If that’s the case, the iShares MSCI Mexico Index Fund (NYSE:EWW[7]) — which is already steadily on its way up — could be a good bet, along with other companies that target the region.

Jon Markman likes the country so much, for example, he picked Fomento Economico Mexicano (NYSE:FMX[8]) in InvestorPlace‘s Best Stocks of 2013[9] contest, saying he believes[10] “Mexico has one of the greatest potential growth profiles in the world.”

Looking at the demographics of its population, he just might be right.

As of this writing, Alyssa Oursler did not own a position in any of the aforementioned securities.

Endnotes:

special dividends: http://investorplace.com/2011/12/special-dividends-bonus-payouts/